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Advanced Credit Risk Analysis and Management

Book Description

Credit is essential in the modern world and creates wealth, provided it is used wisely. The Global Credit Crisis during 2008/2009 has shown that sound understanding of underlying credit risk is crucial. If credit freezes, almost every activity in the economy is affected. The best way to utilize credit and get results is to understand credit risk.

Advanced Credit Risk Analysis and Management helps the reader to understand the various nuances of credit risk. It discusses various techniques to measure, analyze and manage credit risk for both lenders and borrowers. The book begins by defining what credit is and its advantages and disadvantages, the causes of credit risk, a brief historical overview of credit risk analysis and the strategic importance of credit risk in institutions that rely on claims or debtors. The book then details various techniques to study the entity level credit risks, including portfolio level credit risks.

Authored by a credit expert with two decades of experience in corporate finance and corporate credit risk, the book discusses the macroeconomic, industry and financial analysis for the study of credit risk. It covers credit risk grading and explains concepts including PD, EAD and LGD. It also highlights the distinction with equity risks and touches on credit risk pricing and the importance of credit risk in Basel Accords I, II and III. The two most common credit risks, project finance credit risk and working capital credit risk, are covered in detail with illustrations. The role of diversification and credit derivatives in credit portfolio management is considered. It also reflects on how the credit crisis develops in an economy by referring to the bubble formation. The book links with the 2008/2009 credit crisis and carries out an interesting discussion on how the credit crisis may have been avoided by following the fundamentals or principles of credit risk analysis and management.

The book is essential for both lenders and borrowers. Containing case studies adapted from real life examples and exercises, this important text is practical, topical and challenging. It is useful for a wide spectrum of academics and practitioners in credit risk and anyone interested in commercial and corporate credit and related products.

Table of Contents

  1. Cover
  2. Series
  3. Title Page
  4. Copyright
  5. Preface
  6. Part I: Introduction
    1. Chapter 1: Credit Basics
      1. 1.1 MEANING OF CREDIT
      2. 1.2 ROLE OF CREDIT
      3. 1.3 CREDIT MARKET
      4. 1.4 CREDIT – ADVANTAGES AND DISADVANTAGES
      5. 1.5 SUPPLIERS OF CREDIT
      6. 1.6 CREDIT RISK STUDY
      7. APPENDIX: CREDIT CREATION
      8. QUESTIONS/EXERCISES
    2. Chapter 2: Essentials of Credit Risk Analysis
      1. 2.1 MEANING OF CREDIT RISK
      2. 2.2 CAUSES OF CREDIT RISK
      3. 2.3 CREDIT RISK AND RETURN
      4. 2.4 CREDIT RISK ANALYSIS
      5. 2.5 HISTORICAL PROGRESS OF CREDIT RISK ANALYSIS
      6. 2.6 NEED FOR CREDIT RISK ANALYSIS
      7. 2.7 CHALLENGES OF CREDIT RISK ANALYSIS
      8. 2.8 ELEMENTS OF CREDIT RISK ANALYSIS
      9. QUESTIONS/EXERCISES
    3. Chapter 3: Credit Risk Management
      1. 3.1 STRATEGIC POSITION OF CREDIT RISK MANAGEMENT
      2. 3.2 CREDIT RISK MANAGEMENT CONTEXT
      3. 3.3 CREDIT RISK MANAGEMENT OBJECTIVES
      4. 3.4 CREDIT RISK MANAGEMENT STRUCTURE
      5. 3.5 CREDIT RISK CULTURE
      6. 3.6 CREDIT RISK APPETITE
      7. 3.7 CREDIT RISK MANAGEMENT IN NON-FINANCIAL FIRMS
      8. 3.8 CREDIT RISK MANAGEMENT IN FINANCIAL INTERMEDIARIES
      9. QUESTIONS/EXERCISES
  7. Part II: Firm (or) Obligor Credit Risk
    1. Chapter 4: Fundamental Firm/Obligor-Level Risks
      1. 4.1 FIRM (OR) OBLIGOR RISK CLASSIFICATION
      2. 4.2 RISK MATRIX
      3. 4.3 DIFFERENT RISK LEVELS
      4. QUESTIONS/EXERCISES
    2. Chapter 5: External Risks
      1. 5.1 BUSINESS CYCLE
      2. 5.2 ECONOMIC CONDITIONS
      3. 5.3 INFLATION AND DEFLATION
      4. 5.4 BALANCE OF PAYMENTS AND EXCHANGE RATES
      5. 5.5 POLITICAL
      6. 5.6 FISCAL POLICY
      7. 5.7 MONETARY POLICY
      8. 5.8 DEMOGRAPHIC FACTORS
      9. 5.9 REGULATORY FRAMEWORK
      10. 5.10 TECHNOLOGY
      11. 5.11 ENVIRONMENT ISSUES
      12. 5.12 INTERNATIONAL DEVELOPMENTS
      13. 5.13 OTHERS
      14. 5.14 MONITORING EXTERNAL RISKS
      15. QUESTIONS/EXERCISES
    3. Chapter 6: Industry Risks
      1. 6.1 UNDERSTANDING OBLIGOR'S INDUSTRY OR MARKET
      2. 6.2 TYPES OF INDUSTRY RISKS
      3. 6.3 INDUSTRY LIFE CYCLE
      4. 6.4 PERMANENCE OF INDUSTRY
      5. 6.5 GOVERNMENT SUPPORT
      6. 6.6 INDUSTRY AND FACTORS OF PRODUCTION
      7. 6.7 INDUSTRY AND BUSINESS CYCLES
      8. 6.8 INDUSTRY PROFITABILITY
      9. 6.9 COMPETITOR/PEER GROUP ANALYSIS
      10. QUESTIONS/EXERCISES
    4. Chapter 7: Entity-Level Risks
      1. 7.1 UNDERSTANDING THE ACTIVITY
      2. 7.2 RISK CONTEXT AND MANAGEMENT
      3. 7.3 INTERNAL RISK IDENTIFICATION STEPS
      4. 7.4 SWOT ANALYSIS
      5. 7.5 BUSINESS STRATEGY ANALYSIS
      6. 7.6 PITFALLS IN STRATEGY
      7. 7.7 MANAGEMENT ANALYSIS
      8. 7.8 OTHER INTERNAL RISKS
      9. QUESTIONS/EXERCISES
    5. Chapter 8: Financial Risks
      1. 8.1 IMPORTANCE OF FINANCIAL STATEMENTS
      2. 8.2 QUALITY AND QUANTITY OF FINANCIAL STATEMENTS
      3. 8.3 ROLE OF HISTORICAL FINANCIAL STATEMENTS
      4. 8.4 FINANCIAL ANALYSIS
      5. 8.5 ANALYTICAL TOOLS
      6. 8.6 SOLVENCY RATIOS
      7. 8.7 OPERATIONAL RATIOS
      8. 8.8 ENCAPSULATED RATIOS
      9. QUESTIONS/EXERCISES
    6. Chapter 9: Integrated View of Firm-Level Risks
      1. 9.1 RELEVANCE OF AN INTEGRATED VIEW
      2. 9.2 JUDGEMENT
      3. 9.3 IDENTIFYING SIGNIFICANT CREDIT RISKS
      4. 9.4 RISK MITIGANTS
      5. 9.5 TYPES OF MITIGANTS
      6. 9.6 PRINCIPLES TO BE BORNE IN MIND WHILE SELECTING MITIGANTS
      7. 9.7 MONITORING OF CREDIT RISK
      8. APPENDIX – CREDIT RISKS AND POSSIBLE MITIGANTS
      9. QUESTIONS/EXERCISES
    7. Chapter 10: Credit Rating and Probability of Default
      1. 10.1 CREDIT RISK GRADING
      2. 10.2 PROBABILITY OF DEFAULT
      3. 10.3 EXTERNAL VS. INTERNAL RATING
      4. 10.4 PD IN CREDIT STRUCTURAL MODELS
      5. QUESTIONS/EXERCISES
  8. Part III: Credit Risks – Project and Working Capital
    1. Chapter 11: Credit Risks in Project Finance
      1. 11.1 DISTINCTIVE FEATURES OF PROJECT FINANCE
      2. 11.2 TYPES OF PROJECT FINANCE
      3. 11.3 REASONS FOR PROJECT FINANCE
      4. 11.4 PARTIES INVOLVED IN PROJECT FINANCE
      5. 11.5 PHASES OF PROJECT AND RISKS
      6. 11.6 PROJECT CREDIT RISKS
      7. 11.7 FINANCIAL STUDY
      8. 11.8 PROJECT CREDIT RISK MITIGANTS
      9. QUESTIONS/EXERCISES
    2. Chapter 12: Credit Risks in Working Capital
      1. 12.1 DEFINITION OF WORKING CAPITAL
      2. 12.2 ASSESSING WORKING CAPITAL THROUGH THE BALANCE SHEET
      3. 12.3 WORKING CAPITAL RATIOS
      4. 12.4 WORKING CAPITAL CYCLE
      5. 12.5 WORKING CAPITAL VS. FIXED CAPITAL
      6. 12.6 WORKING CAPITAL BEHAVIOUR
      7. 12.7 WORKING CAPITAL, PROFITABILITY AND CASH FLOWS
      8. 12.8 WORKING CAPITAL RISKS
      9. 12.9 IMPACT OF WORKING CAPITAL RISKS
      10. 12.10 WORKING CAPITAL RISK MITIGANTS
      11. 12.11 WORKING CAPITAL FINANCING
      12. QUESTIONS/EXERCISES
  9. Part IV: Credit Portfolio Risks
    1. Chapter 13: Credit Portfolio Fundamentals
      1. 13.1 CREDIT PORTFOLIO VS. EQUITY PORTFOLIO
      2. 13.2 CRITICALITY OF PORTFOLIO CREDIT RISKS
      3. 13.3 BENEFITS OF CREDIT PORTFOLIO STUDY
      4. 13.4 PORTFOLIO ANALYSIS
      5. 13.5 CREDIT PORTFOLIO RISK VS. RETURN
      6. APPENDIX: ORGANIZATIONAL CONFLICT IN CREDIT RISK MANAGEMENT
      7. QUESTIONS/EXERCISES
    2. Chapter 14: Major Portfolio Risks
      1. 14.1 SYSTEMATIC RISK
      2. 14.2 DIVERSIFIABLE RISK
      3. 14.3 CONCENTRATION
      4. 14.4 CREDIT PORTFOLIO BETA
      5. QUESTIONS/EXERCISES
    3. Chapter 15: Firm Risks to Portfolio Risks and Capital Adequacy
      1. 15.1 OBLIGOR PD AND PORTFOLIO PD
      2. 15.2 MIGRATION RISK
      3. 15.3 DEFAULT RISK
      4. 15.4 LOSS GIVEN DEFAULT (LGD)
      5. 15.5 EXPECTED LOSS (EL)
      6. 15.6 PROVISIONING
      7. 15.7 CREDIT LOSS DISTRIBUTION
      8. 15.8 ECONOMIC CAPITAL
      9. QUESTIONS/EXERCISES
    4. Chapter 16: Credit Risk and The Basel Accords
      1. 16.1 BASEL ACCORDS
      2. 16.2 BASEL I (1988) – FIRST BASEL ACCORD
      3. 16.3 BASEL ACCORD II (2006)
      4. 16.4 BASEL III
      5. APPENDIX
      6. QUESTIONS/EXERCISES
  10. Part V: Portfolio Risk Mitigants
    1. Chapter 17: Credit Risk Diversification
      1. 17.1 TRADITIONAL DIVERSIFICATION
      2. 17.2 MODERN DIVERSIFICATION OF CREDIT PORTFOLIO
      3. 17.3 CORRELATIONS IN CREDIT RISK MODELS
      4. QUESTIONS/EXERCISES
    2. Chapter 18: Trading of Credit Assets
      1. 18.1 SYNDICATED LOANS/CREDIT ASSETS
      2. 18.2 SECURITIZATION
      3. 18.3 DISTRESSED DEBT
      4. 18.4 FACTORING
      5. 18.5 DISTRESSED RECEIVABLES
      6. QUESTIONS/EXERCISES
    3. Chapter 19: Credit Derivatives
      1. 19.1 MEANING OF A CREDIT DERIVATIVE
      2. 19.2 CREDIT DEFAULT SWAP (CDS)
      3. 19.3 TOTAL RETURN SWAP
      4. 19.4 CREDIT OPTION (CO)
      5. 19.5 CREDIT SPREAD OPTIONS (CSO)
      6. 19.6 CREDIT DERIVATIVE LINKED STRUCTURES
      7. 19.7 FUTURE OF CREDIT DERIVATIVES
      8. 19.8 CREDIT DERIVATIVES AND OVER-THE-COUNTER (OTC) MARKETS
      9. QUESTIONS/EXERCISES
  11. Part VI: Credit Risk Pricing
    1. Chapter 20: Pricing Basics
      1. 20.1 CREDIT PRICING FACTORS
      2. 20.2 PRICING STRUCTURE
      3. 20.3 CREDIT RISK PRICING MODEL
      4. 20.4 PRIME LENDING RATE
      5. QUESTIONS/EXERCISES
    2. Chapter 21: Pricing Methods
      1. 21.1 RORAC (RETURN ON RISK-ADJUSTED CAPITAL) BASED PRICING
      2. 21.2 MARKET DETERMINED
      3. 21.3 ECONOMIC PROFIT BASED PRICING
      4. 21.4 COST PLUS
      5. 21.5 STRUCTURED PRICING
      6. 21.6 GRID PRICING
      7. 21.7 NET PRESENT VALUE (NPV) PRICING
      8. 21.8 RANPV (RISK-ADJUSTED NPV) PRICING
      9. QUESTIONS/EXERCISES
  12. Part VII: The Last Line of Defence — Security
    1. Chapter 22: Security Basics
      1. 22.1 NEED FOR SECURITY
      2. 22.2 MERITS AND DEMERITS OF A SECURITY
      3. 22.3 ATTRIBUTES OF A GOOD SECURITY
      4. 22.4 SECURITY AND PRICING
      5. 22.5 IMPACT OF SYSTEMATIC RISKS ON SECURITY
      6. 22.6 FACILITY GRADES
      7. QUESTIONS/EXERCISES
    2. Chapter 23: Collaterals and Covenants
      1. 23.1 TANGIBLE SECURITY
      2. 23.2 INTANGIBLE SECURITY
      3. 23.3 METHODS OF TAKING SECURITY
      4. 23.4 REALIZING SECURITY
      5. 23.5 COVENANTS – A TRIGGER TO SEEK ADDITIONAL SECURITY
      6. QUESTIONS/EXERCISES
  13. Part VIII: Credit Crisis
    1. Chapter 24: Road to Credit Crisis
      1. 24.1 CREDIT AND GROWTH
      2. 24.2 ROLE OF BANKS
      3. 24.3 FORMATION OF CREDIT BUBBLES
      4. 24.4 TYPES OF CREDIT BUBBLE
      5. 24.5 CREDIT BUBBLE EXPLOSION
      6. QUESTIONS/EXERCISES
    2. Chapter 25: 2008 Credit Crisis
      1. 25.1 CREDIT ASSET – PRIME VS. SUB-PRIME
      2. 25.2 SECURITIZATION
      3. 25.3 US HOUSING BUBBLE4
      4. 25.4 ROLE OF OTC DERIVATIVES
      5. 25.5 ROLE OF RATING AGENCIES
      6. 25.6 WHY DID THE BUBBLE BURST?
      7. 25.7 CONSEQUENCES
      8. 25.8 IMPACT OF THE LEHMAN COLLAPSE
      9. 25.9 HOUSING CRISIS TO CREDIT CRISIS TO ECONOMIC CRISIS
      10. 25.10 COMMON FACTORS 1929 vs. 2009
      11. 25.11 LESSONS OF THE 2008 CREDIT CRISIS
      12. QUESTIONS/EXERCISES
  14. Bibliography
  15. Index